The Sixth Circuit expounded on a loophole in the Rooker-Feldman doctrine that will sometimes allow a bankruptcy court to disregard a state court judgment upholding the validity and enforceability of a mortgage.
Named for two Supreme Court decisions, Rooker-Feldman means that federal courts lack subject matter jurisdiction to review judgments by state courts. In other words, someone cannot mount a lawsuit in federal court amounting to an appeal from a state court judgment.
In Hamilton v. Herr (In re Hamilton), 540 F.3d 367 (6th Cir. 2008), the Sixth Circuit laid down a rule dealing with situations where Rooker-Feldman collides with discharge under Section 524(a).
Hamilton involved a situation where a state court had ruled that a debt was not discharged. Could the debtor then ask the bankruptcy court, in effect, to overrule the state court and hold that the debt was discharged? Would the debtor’s resorting to bankruptcy court violate Rooker-Feldman?
As Sixth Circuit Judge John M. Rogers said in his July 18 opinion, Hamilton means that “state courts may interpret discharge orders, but only if they do so correctly. Otherwise, they violate Section 524(a) by modifying the discharge order . . . . When a state court interprets the discharge order incorrectly, its judgment is void ab initio and therefore poses no Rooker-Feldman bar to subsequent review in the lower federal courts.”
The applicability of Hamilton was the centerpiece of the appeal before the Sixth Circuit.
The Unrecorded Mortgage
In her chapter 7 petition in 2004, the debtor scheduled a second mortgage on her home as a secured claim. The debtor received her discharge, not knowing that the lender failed to record the mortgage until three months after bankruptcy. Recordation occurred about a month before discharge, thus apparently in violation of the automatic stay.
The debtor stopped paying the mortgage about two years after bankruptcy. More than 10 years after bankruptcy, the lender began foreclosure in state court. The state court ruled that the second mortgage was valid and enforceable. Just before the foreclosure sale, the debtor filed a chapter 13 petition and initiated an adversary proceeding to avoid the lien under the Section 544(a) strong-arm powers.
The debtor proffered two theories. The bankruptcy court did not rule on the first, where she sought to avoid the mortgage under the strong-arm powers, contending that it was never properly perfected.
Instead, the bankruptcy court ruled in her favor on a second theory: that the mortgage had never attached because a nonstandard provision in the mortgage required recordation as a condition to attachment.
The Bankruptcy Appellate Panel reversed, based on Rooker-Feldman. Although the first theory was raised in the BAP, the panel did not rule on the issue, thus preserving the question for Sixth Circuit review. To read ABI’s discussion of the BAP opinion, click here.
The Circuit’s Opinion
To rule on the applicability of Rooker-Feldman, Judge Rogers analyzed both of the debtor’s theories. He concluded that the doctrine precluded granting relief under the second theory but not the first.
The second claim – that the mortgage was unenforceable because the lien never attached – was barred by Rooker-Feldman because it amounted to an appeal from the state court’s judgment that the mortgage was valid and enforceable. To rule in the debtor’s favor, Judge Rogers said, “the bankruptcy court would need to reach a conclusion precisely opposite from the state court on the issue of whether the lien attached.”
Consequently, Hamilton did not apply to that theory, because Section 524(a) “only protects debtors from being held personally liable for discharged debts,” Judge Rogers said. [Emphasis in original.] The discharge injunction, he said, does not prohibit a creditor from foreclosing on a valid lien that existed before bankruptcy.
By upholding the validity of the lien, the state court in no manner affected the debtor’s personal liability. Thus, the bankruptcy court improperly ruled in favor of the debtor.
On the other hand, Judge Rogers ruled that Rooker-Feldman did not prelude the bankruptcy court from granting relief under the strong-arm power. Recall that neither the bankruptcy court nor the BAP had ruled on that theory.
The strong-arm theory rested on the notion that the mortgage was never validly perfected because it was recorded in violation of the automatic stay. Rooker-Feldman therefore did not apply, Judge Rogers said, because “it does not invite the bankruptcy court to review the state court’s handiwork.”
Judge Rogers went on to say that the “bankruptcy court could accept the state court’s judgment as completely correct when entered, yet still rule for [the debtor] on the ground that the lien was never perfected.”
Because the strong-arm theory had not been litigated, the circuit court reversed and remanded for the claim to “be decided in the first instance in the court or courts below.” The appeals court expressed no view on the validity of the strong-arm theory.
The Chapter 13 Debtor’s Standing
The lender argued on appeal that the chapter 13 debtor had no standing, contending that the strong-arm claim was property in the earlier chapter 7 case and was not part of the later chapter 13 estate.
The question of whether only the chapter 13 trustee could prosecute the strong-arm claim was not an issue because the trustee consented to the debtor’s motion for derivative standing.
Judge Rogers said that the lender offered “no suggestion why [the strong-arm] claims would not have been included in” the chapter 13 estate. He said that the lender’s argument was “inconsistent with the text of Section 544(a)[, which] indicates that Section 544(a) rights are granted anew each time the debtor files for bankruptcy.”